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Two recent decisions highlight issues for accountants when valuing shares in a business

In the first case1 the claimant director (M) claimed damages against a firm of auditors (N) on the basis that N had negligently undervalued his shareholding in a company (L).

M was a minority shareholder in L, holding 5% of the class B shares. He left the board and company in acrimonious circumstances in December 2003. Under the Articles of Association of the company, he was required to relinquish his shares to the other shareholders, the price to be fixed by L’s auditors (N) for a fair value, which the shares might reasonably be expected to fetch in the open market. In so doing, N were to be considered experts and not arbitrators.

N produced a valuation of £128 per share as at 15 June 2004. M submitted that this was an under valuation. M relied on the fact that N was also the auditor for Trustco and had valued Trustco’s 2.1% of L's shares at £620 per share at the time of the 15 June valuation.

At trial, N admitted negligence but denied liability on the basis that the £128 per share valuation fell within the range of values that could have been determined by a reasonable valuer acting properly.

The judge found it difficult to reconcile how N had valued M’s shareholdings at £128 per share whilst approving a figure of £620 per share in Trustco’s accounts. This was symptomatic of N’s negligent willingness to submit to pressure from the directors of L to keep the value of M’s minority shareholding as low as possible, and a failure to keep an independent balance between the interests of the remaining directors of L on the one hand and M on the other.

The second case2 concerned the valuation of a share in a firm of estate agents (the partnership) on the retirement of one partner. Harwood Hutton (H) were the partnership’s accountants. Mr Carr (Carr) was the retiring partner.

The partnership agreement contained a leaving provision such that a departing partner would be paid a sum which included a share of the goodwill of the partnership, to be determined by H in their absolute discretion. H’s letter of engagement included a limit of liability to a maximum of “twentyfive times the fee charged for each segment of work done”.

In October 1999, Carr considered retiring from the partnership and approached H for advice on how much he might receive. H provided a valuation (the initial valuation) to him. Carr then informed the other partners of his intention to retire and gave them copies of the initial valuation.

After Carr had given his formal notice of retirement, H prepared a further draft valuation (the February valuation) for the remaining partnership. Carr obtained a copy of that valuation and sought independent advice which concluded that the February valuation had undervalued his interest.

The claimants (the remaining partners in the partnership) submitted that the initial valuation was incorrect, and that H’s provision of the initial valuation to Carr in a personal capacity was a breach of H’s fiduciary duty to the rest of the partnership. As a result of this breach, Carr’s expectations were incorrectly raised, resulting in dispute and legal costs, which they sought to recover.

The judge found no fault with the initial valuation but noted that whether a valuation was correct was not determinative of negligence. Negligence depended on whether H had undertaken the task with the care and skill to be expected of a reasonably competent member of the profession. No criticism had been made of the methodology used and accordingly the negligence claims failed.

On the issue of breach of fiduciary duty, the judge agreed that it was the nature of the leaving provision, that it would place the firm’s accountants in a position of conflict between the departing partner who would want a high valuation and the remaining partnership who would want a low valuation.

At the time of the October 1999 valuation, H were in a potential conflict position, but because all the partners knew and agreed that H:

were the partnership's accountants

would undertake a valuation if one of the partners were to leave and

acted personally for each of them in relation to their tax affairs,

none of the partners could complain, because each one was informed and had consented to that potential for conflict.

In considering the limit of liability, the judge accepted that the reasonableness test contained in s11 of the Unfair Contract Terms Act 1977 applied in substance even though the multiplier was not a “specified sum”. As the defendants had submitted no evidence to support its reasonableness, H had failed to discharge the burden of establishing that the provision was reasonable.

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Compare jurisdictions:Arbitration

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